Understanding the Odds of a Double-Dip Recession

How likely is it to occur -- and why are we so fixated on it?

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Understanding the Odds of a Double-Dip Recession

In the past few decades, the specter of the "double-dip recession" has established itself in the collective consciousness of the American public as a sort of phantasm that lurks just around the corner of every economic recovery. Judging by the frequency and intensity of the media attention that it garners, the fear of this economic menace has become deeply ingrained in the American public.

How justified are these fears? How likely is it that such an event will occur in 2010?

A History of Double-Dip Recessions

To compute the odds of a given event occurring, it helps to understand when and how such events have occurred in the past.

We should first define what a double dip recession is. For purposes of this article, we shall adopt the most common definition utilized by economists -- and one which also happens to make common sense: A double dip recession is an occurrence whereby the US economy enters into a recession within a period less than 12 months following the end of the previous recession.

According to the National Bureau of Economic Research (NBER), the most authoritative source of information regarding business cycles, there have been 33 recessions registered in the US since 1854. Over this entire time frame, there have been only three recorded instances of a double-dip recession by this standard definition. The first one was in 1913, the second in 1920, and the third in 1981.

(Note: If we make the definition of a double-dip more expansive, including all recessions within 18 months of the end of the previous recession, the number of occurrences of double-dips rises only slightly to five.)

So let us summarize the history of double-dip recessions according to the standard definition: There were two instances of double-dips in the 91 year period from 1854 to 1945, which comprised a total of 22 business cycles. And there was just one instance a double-dip in the 11 business cycles that took place during the 65 years that have transpired since 1945.

That's it.

So, what can we surmise from this information? Historically speaking, a double-dip recession is an extraordinarily rare occurrence; almost insignificant from a statistical point of view.

Furthermore, from an analytical standpoint, it's doubtful whether a "double-dip recession" is even a distinct category of economic event that's worthy of study, or even mention. For there's virtually nothing which the three double-dip recessions share in common that could identify them as belonging to a distinct category of economic phenomena. The nature and causes of the three recessions were so disparate that they appear to be entirely isolated events.

Conclusion: Double-dip recessions have been extremely rare and isolated events. There are virtually no historically derived indicators that could help one foresee such an unlikely phenomenon at this time. Some Good Old Common Sense

Why have double-dips been so rare? Fortunately, the explanation happens to jive with common sense understandings and basic intuitions of how economies work.

First of all, most folks understand that the process of economic growth is a cyclical phenomenon.

Second, most folks can intuitively understand that the acceleration and deceleration of aggregate economic activity exhibits properties that are akin to the concept of momentum. Folks understand that the flow of activity in a large economy simply can't and doesn't turn on a dime. The reason for this inertia is, in part, that a large economy is comprised of millions of interrelated actors performing millions of interlinked transactions, most of which require considerable lead times to manifest (e.g. demand to design to financing to production to distribution through to final sale).

The key insight to take away is this: Once an economy has hit bottom and starts growing (even from a very low base), inertial forces take over and it's extremely unlikely that the momentum will be halted in the early phase of the "bounce" off the trough. Furthermore, due to the low statistical baseline established during the trough, it's overwhelmingly likely that economic growth will be reflected in the statistics in the period immediately following.

(Note: Just because an economy is growing doesn't mean that it's necessarily healthy or that its people are prosperous. It just means that the economy is growing.)

All of this brings us back to double-dips. A double-dip requires an abrupt halting and reversal of economic momentum immediately after passing through the trough and during the early part of the "bounce" phase. As such, conceptually speaking, such an event is highly unlikely by its very nature. And as we saw earlier, this basic prediction has been amply confirmed by the historical record.

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